The next stock market crash will mean different things for different people. For some, it will cause crippling declines in their retirement accounts while for others it will present an opportunity to acquire all of their favorite stocks at basement bargain prices. Regardless of how the next stock market crash will impact your own personal financial situation, knowing when one could happen next is key to preparing accordingly. As such, let’s look at 7 signs the stock market is going to crash so that you can fully capitalize the next time the market takes a dive!
Sign #1: Dovish Monetary Policy
When we think of doves, we often think of birds who have forever been linked with sentiments of love and affection. Well, I hate to burst your love bubble but in the context of monetary policy and stock market crashes, doves may be synonymous with decline.
When the monetary policy in the country is dovish, it basically means that policymakers are aiming to keep interest rates low. Now, what usually happens when interest rates are low? If you’ve been paying attention over the last couple of years you’ve probably seen droves of people borrowing money because the second-best thing to free money is cheap money and right now there’s lots of it. Now, this may not seem like a bad thing but as you know, nothing good lasts forever and over time, this supply of cheap cash will disappear and this will push the market towards a crash. Why is that? Let me explain.
You see, right now, there are a lot of investors who are using borrowed money to prop up their investing positions. However, as borrowing becomes more and more expensive as interest rates rise, less and less people will continue to borrow meaning they will have less access to capital and as such less stocks will end up being purchased. This contraction in purchasing or lower demand, will naturally cause stock prices to fall and if this change in price prompts further sell offs then you get into a situation where the market can take a turn for the worst real quick.
Therefore, as periods of low-interest prevail, you should suspect that the tides will eventually turn and that a market crash is very likely to take place.
Sign #2: Market Bubbles
You’ve probably never had this thought before but both as kids and adults, we’ve found ourselves amidst bubbles. As a child, you probably used blowing bubbles as a form of entertainment, however as you grew older, your interactions with bubbles mainly pertained to those in the financial world we live in. Well, let me tell you that bubbles are definitely going to be less enjoyable in your adulthood than they were in your youth because when they get too inflated, they are a clear sign that a stock market crash is on the way.
Now, of course historical events are not an exact way to predict the future but if past bubbles have taught us anything it’s that with all good comes some bad. For instance, in the mid to late nineties, the tech market was absolutely booming with the Nasdaq rising 400% over that time. However, as you probably know, these glorious times were short lived with the index falling 78% from its peak by October 2002.
Another great example of a bubble many of us have witnessed came in 2008 with the housing crisis. In the years leading up to the crash, many creditors held very relaxed credit policies and people were buying houses like it was their day job. How did they afford this? With the extensive low-interest loans the banks were offering them of course! However, as you know, nothing in life is free and when interest rates started to rise, people’s mortgage payments became more than they could handle which led to extensive defaults on payments and ultimately a collapse of the US financial system.
Now, if you’ve been paying attention then you’ve probably noticed that lately we’ve been seeing headlines indicating that the market indices have been hitting all-time highs. I’m not saying that this is a surefire sign that the market will crash tomorrow but what goes up must come down. So, when things appear to be too good for too long, you should start to move with caution.
Sign #3: An Extensive Bull Market
Have you ever been going through life and thought to yourself, “wow, life is going great. Uh oh, this must mean something bad is about to happen!” I’ve felt this way from time to time and I think we start to feel this way more with age because we come more aware that with all good comes some bad and life is definitely full of surprises. Well, the stock market is the same and unfortunately, while we would all love to see our investments rise in perpetuity, this isn’t isn’t going to happen.
Now, as unfortunate as this reality is, knowing that bad will proceed the good you experience is key to managing the next market crash. In particular, understanding historical bear and bull market cycles is a great place to start when planning out your own market crash gameplan.
Historically speaking, the average bull market lasts nearly 1000 days or just around three years. This means that you can use this figure to get a rough idea of how long the good times should last and ideally can use this timeframe as a metric for your own financial planning.
Now, keep in mind that this is just an average figure and that some bear and bull markets will be longer than others so this is far from being an exact science. For example, we just had a bear market in the winter of 2020 when we saw the market take a dip amidst the start of the pandemic. During February and March of 2020, the market took a hefty slide only to re-enter a bull market a month later in April 2020. Now, on average, bear markets last 289 days and as you can see this bear market was much shorter so again history should only act as a mere guide and not a surefire answer to any of your stock market crash questions.
However, this is all to say that when times have been good for extended periods of time, the anticipation of a stock market crash should start to enter your head and with all the press constantly around the stock market being blasted at us daily, chances are you will have a hard time missing it!
Sign #4: Concerning Fear & Greed Index
There are only ever two sentiments that exist in the stock market and they are fear and greed. Fortunately, you never have to guess which one is prevailing thanks to a handy tool created by CNN Money called the Fear & Greed Index. This index indicates how investors are feeling about the state of the market and as you can guess, when people are fearful, their buying frequency declines and when they are greedy their purchasing ramps up.
Now, being in a state of fear or greed is not inherently bad. The trouble is when the index swings from one side to another, particularly when we go from being greedy to being fearful. When this takes place, investors who were pumping money into the market start to hold off and this decline in demand pushes down prices leading to people selling off and further prices declines. Therefore, if you want to get a gauge on potential market crashes, keep an eye on the Fear & Greed index as it may be able to act as a tool in your market crash preparation toolkit!
Sign #5: Rising Inflation
Inflation is a term that we’ve all grown to become aware of recently given that it’s about all the world of finance talks about these days. While this is not exactly the most interesting of financial topics, understanding what inflation is and how its changes impact the market is key to identifying and preparing for a stock market crash. Inflation can be defined as a general increase in prices and fall in the purchasing value of money. It’s why when you go to the grocery store, you constantly see workers re-pricing their inventory because prices naturally go up over time. As I said, this is normal and the US Federal Reserve aims to keep inflation at about 2% but when inflation starts to climb, you need to take notice.
As inflation rises, people tend to become more fiscally responsible and hold their dollars a little bit closer to their chest. As such, less spending takes place, company profits decline and stock prices go down with it.
Therefore, if you want to become more aware of stock market crash signs, keep an eye on inflation trends because they may just help you see the next market crash coming sooner than your uneducated peers!
Sign #6: An Inflated Buffett Indicator
When you think of investing, you naturally think of Warren Buffett so it only makes sense that this investing magnate has his own metric for gauging the state of the stock market. If you’re unfamiliar, the Buffett Indicator is a measure of the valuation of the stock market in its current state. The indicator works by comparing the total value of the US stock market to the US GDP. When the indicator yields a result of between 75–90%, Buffett says that the market is fairly valued. Can you take a guess at what that percentage has been lately?
Try well above 200%! This means that the stock market is more than double the valuation it should be based on Buffett’s indicator. As we talked about earlier, when stock prices are inflated, this can only mean one thing, the stock market is set to implode as we’ve seen numerous times in the past. Now, I will admit that the indicator has been running hot for a while and things have stayed afloat but again what goes up must come down so this is all to say that I wouldn’t be surprised if we are in for a correction in the near future!
Sign #7: Declining Property Sales
If you’ve made it this far then I think you deserve to be let in on one of the less talked about indicators that a stock market crash may be on its way. Generally speaking, when you start to see a decline in property sales, it’s time to take note. Now, what constitutes property sales? Good question. In this context, what I mean is a decline in purchasing of any normally bought personal property. This could mean family vehicles, boats and even houses.
Basically, whenever people start to shy away from buying bigger ticket items, it may be a sign that the stock market is in for some turbulent times. Why is that? Well, when people buy these more expensive goods, it typically indicates that people have an optimistic view of the current financial state of the nation. People buy things because they anticipate that an expanding economy will support their purchase whether that’s in the rise of their portfolio values or the raises and promotions they intend to receive at work. However, when times are looking less prosperous, people act in reverse.
When sentiments around the market are pessimistic, people spend less and sell out of the market, preferring to keep their assets in cash. When this happens on a large scale, you guessed it, a stock market crash may ensue.
Therefore, if you start to see ads on TV of car salesmen begging you to buy a car or hear of rising inventory in your local housing market, it may be an early sign that tough times for the stock market are ahead!